Agora Financial’s Rude Awakening

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Laguna Beach, California

• What “GLD’s” largest holder has to say about his metal of choice,
• Anti-dollars continue their record breaking streak,
• Trading inflation fears in for hard assets and more…

Eric Fry, reporting from Laguna Beach, California…

The “inflation trade,” which has been building momentum for several weeks, seemed to pick up a fresh burst of vitality yesterday. Gold reached a new all-time high of $1,060 an ounce, oil brushed up against a one-year high of $75 a barrel, and the agricultural commodities finally joined in on the fun…as corn and wheat both soared more than 5%.

So what does yesterday’s effervescent trading action in the commodity pits mean? Does it prove that the threat of inflation is alive and well? Well, “prove” is probably too strong a word. But yesterday’s trading action does, at least, suggest that the threat of inflation is far from dead. Some investors are defending themselves from this monetary assault by piling up ramparts of gold…and oil.

Read on…

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The “Inflation Trade,” as Sexy as Ever
By Eric J. Fry

Is the threat of inflation advancing? Depends whom you ask.

If you ask Bill Gross, manager of tens of billions of dollars worth of investments that would suffer during an inflation, the answer would be “no.” But if you ask the guy who just made a few billion dollars betting that mortgage-backed securities would collapse during 2008, the answer would be “maybe.” So let’s ask that second guy…

John Paulson, a guy who made billions from a variety of bets against the American financial sector, is a bit worried about the prospect of inflation and a lot worried about the U.S. dollar. That’s why Mr. Paulson has been amassing substantial investments in gold and gold-mining companies. As we noted in a recent edition of the Rude Awakening, Paulson’s hedge fund is the largest holder of “GLD,” the NYSE-traded ETF that holds gold bullion.

A couple weeks back, Paulson explained his affinity for gold to the attendees of the Grant’s Interest Rate Observer Fall Conference. Said Paulson: “I lost faith in the dollar as a reserve currency for my assets…What I’m looking at is not were gold is going to be tomorrow, one week from now, one month from now, three months from now. What I’m looking at is where gold is going to be vis-à-vis the dollar one year from now, three years from now, five years from now. And I think with a high probability at each one of those points, gold will be higher than it is relative to the dollar today. That probability increases the further out you go. So when I looked at what the risk is, the risk to me is far more staying in dollars than it is in gold at this point.”

Paulson seems to have a lot of company at the moment…maybe too much. Gold is “overbought” on the short term and is, therefore, vulnerable to a correction. Paulson says he doesn’t care. Perhaps no other long-term investor should care either. Or maybe long-term investors should care just enough to look around at some of the “other” inflation hedges that are kicking around in the financial markets? What about oil, for example?

Jim Grant, host of the above-mentioned conference, and also a bull on the oil price, makes a compelling argument for investing in the gooey black energy source. “Oil is becoming harder to lift,” Grant observes, “even as money is becoming easier to print…Overlaying the first trend on the second, a speculative thinker can imagine a much higher oil price.” Perhaps these trends are overlaying one another already. “The U.S. dollar index, which tracks the dollar against other major currencies, is down 14 percent since early March,” Bloomberg News calculates, “and crude has jumped by about $20 per barrel [during the same timeframe].”

Andrew Hall, chairman and chief executive of Phibro LLC, is also bullish on the oil price…or at least he was when he was presenting his thoughts at the same Grant’s Conference that featured John Paulson. But Hall’s bullish outlook has nothing to do with the dollar and everything to do with the oil supply. The truth about oil, says Hall, is that production is ebbing while demand is rising.

“Today, it is not so much a question of if the rate of oil supply is going to peak,” he explains, “but when…Oil production in many parts of the world has already peaked and entered a terminal decline that even sustained high prices are unable to reverse.”

The International Energy Agency’s latest data seem to corroborate Hall’s analysis. “August global oil supply was down 400,000 barrels a day to 84.9 mb/d, on lower non-OPEC output.” Meanwhile, the IEA also predicted that worldwide demand for crude oil would rise to about 85.7 mb/d next year – or nearly one million barrels per day more than current production.

“But what about all those great big oil discoveries we’ve been reading about recently?” some readers may be wondering. “Won’t those finds compensate for production declines elsewhere?” In a word, no. The recent discoveries off the coasts of Brazil, West Africa and elsewhere might slow the rate of global production declines, but they are unlikely to produce global production increases.  Here’s why: production is falling off rapidly at many of the world’s largest oil fields, most notably the Cantarell Field off the coast of Mexico.

This “super giant” was producing 2.2 mb/d as recently as 2003. Next year it will be lucky to produce 500,000 barrels per day. Furthermore, it is worth noting that Cantarell’s oil lies under a mere 150 feet of water and 3,500 feet of rock. The oil contained in Brazil’s headline-grabbing Tupi discovery lies under about 6,500 feet of water and 16,000 feet of rock, sand and salt. The very first exploratory well into this four-mile-deep deposit cost about $200 million. Subsequent wells will probably cost more than $60 million apiece. In other words, the oil will not be easy to get…which suggest that tomorrow’s oil will be more expensive than today’s.

The considerable constraints on the growth of new supplies should contribute to a steadily rising oil price for several years to come. As Andrew Hall, chairman and CEO of Phibro LLC, remarked during his presentation at the Grant’s investor conference, “Extreme oil price volatility with an upward bias is virtually guaranteed.”

Investors seeking to capitalize on a rising oil price have no shortage of options.  But please check in again later this week as Chris Mayer, editor of Mayer’s Special Situations, highlights a couple of his favorite ideas in the energy patch…

Joel’s Note: Of course, if you simply can not wait to see Mayer’s favorite energy play, you can always just grab a copy to his premium research service here. Just a thought…

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[Rude Endnote: The end is nigh, faithful (and unfaithful) readers. Only three more Rude issues remain until we retire the ol’ publication…and take up our new post over at The Daily Reckoning.

This change will occur next Monday. If you don’t want to miss an issue, we suggest you sign up for “The DR” – free, of course – right here.

We hope you’ll be able to join us.

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com